Oil Drops Below $40 as Saudi Urges Bigger Output Hike

NEW YORK – Oil futures closed below the key $40-a-barrel threshold Friday after Saudi Arabia proposed raising OPEC (search) output quotas by more than 2 million barrels per day and said it was committed to boosting supplies in June in a bid to cool markets.

The Saudi statement, which one analyst called a "shock treatment" for runaway oil prices, came on the eve of a conference in Amsterdam between oil producers and consumer nations, who want to convince OPEC nations to open their taps.

Crude prices have risen almost 30 percent under year-ago levels.

U.S. light crude (search) fell more than $1 to trade at a low of $39.65 a barrel before closing at $39.93, the first settlement price under $40 in 10 days. On Monday, it struck a 21-year peak of $41.85.

Gasoline futures (search) — which had felled much of the oil rally this week on concerns over tight U.S. inventories — slumped 2.3 percent to end at $1.4168 a gallon.

The oil price fall reverberated to other markets, sending the key U.S. stock index higher. Traders said the Saudi news eased worries that soaring energy costs may derail economic growth.

Saudi Arabia, OPEC's largest producer and the only one with substantial spare production capacity, proposed the cartel boost its oil output by more than 2 million bpd, 8.5 percent above its existing limits of 23.5 million barrels daily.

"The recent increase in oil demand and supply projections for the coming months point to an increase in required production from OPEC by an excess of 2 million bpd," Saudi Oil Minister Ali al-Naimi said in a statement.

Naimi said Saudi Arabia had already allocated its customers more than 9 million bpd crude for June. This is far in excess of independently estimated Saudi output of 8.6 million this month and 8.2 million in April, as well as the kingdom's official quota of 7.63 million bpd.

"The Saudis are trying shock treatment," said Nauman Barakat, senior vice president at brokers Refco.

"The question is will this do the trick. With this sort of increase the Saudis effectively have played their last card, because once they do this there's no further scope for any real extra production."

OPEC ministers as well as analysts agree the cartel probably has limited power this time to influence prices, because the price spike is not due to a supply shortage.

Consultancy Petrologistics said on Friday OPEC was already pumping 2.8 million bpd above quota in May, with little impact on the oil price. Besides, most OPEC crude is of the heavy, sour variety, while refineries require lighter grades.

"I don't think that control is in OPEC's hands," UAE Oil Minister Obaid al-Nasseri said. "There are many factors behind these prices."

John Waterlow, an analyst at WoodMacKenzie in Edinburgh, said speculative buying, fear of supply disruptions in the Middle East and shortages of gasoline were helping drive prices.

"An unequivocal signal from OPEC could help calm the markets a bit, but there are all sorts of other issues influencing the price this time," Waterlow said.

"We also have to bear in mind that the peak season for gasoline demand in the United States is yet to come and there is no sign of any immediate relief to that problem," he added.

OPEC delegates said any formal decision on increasing crude supplies would be taken at the cartel's official meeting June 3 and not at this weekend's gathering in Amsterdam.

The current high crude prices have put OPEC under pressure from consuming nations, which fear that runaway oil prices could derail world economic growth.

U.S. Treasury Secretary John Snow, speaking in Columbus, Ohio, said on Friday he would support an expected call by the Group of Seven richest nations for OPEC to increase output.

The finance ministers of the G7 are meeting this weekend in New York. Snow, in an interview with West Virginia Radio News Network, said high oil prices "will be much on our minds" during the meeting.